After Three-Plus Months of Rising in Almost a Straight Line, a Market Correction was Due. Now that It’s Arrived, Here’s How to Play It.
What started as a slow trickle last week was confirmed by a veritable flood on Monday—the long-feared stock market pullback has arrived. As an investor, your first instinct may be to panic and make some irrational decisions with your portfolio. But here’s why I think this pullback is a good thing.
A week ago, stocks were at all-time highs, and had been rising in almost a straight line since early October, with the S&P 500 up 15% in just over three months. Now it’s down in three of the last five trading sessions, falling more than 2%; perhaps more telling, the Chicago Board of Options Volatility Index (VIX) has spiked above 17 for the first time since the market rally started in early October.
Jacob Mintz, our options trading expert and a former market maker on the Chicago Board of Options trading floor, has long said that 17 is the level above which the VIX starts to reveal some meaningful selling.
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“My general rule,” Jacob wrote to his Cabot Options Trader subscribers before the open on Monday, “is I don’t get too concerned about the VIX until it trades above 17. That being said, what would really get me concerned is if the VIX shot from 14 to 18 or above in one day, as the velocity of that move would tell me that traders are aggressively buying puts.”
Well, that’s precisely what happened—the VIX entered Monday at 14 and spiked as high as 18 in early trading. That means institutional investors are indeed selling. More than likely, that means there will be more selling in the days to come.
Stock Market Pullback Likely to Be Short?
How long will the stock market pullback last? No one knows. The spreading coronavirus, which has already claimed more than 80 lives in China with more reported cases around the globe, including five in the U.S. as of this writing, was clearly a major catalyst for this particular market correction. Two months ago, Wall Street may have completely ignored the coronavirus. But when stocks run up quickly over an extended period of time, investors start to look for a reason to sell. The coronavirus was a good excuse.
How deep will this pullback be? Mike Cintolo, our resident market expert and an award-winning market timer, has been warning our readers of a 5%-6% correction. Ultimately, however, Mike thinks the pullback will be a good thing—a chance for investors who had been leery of buying stocks at such elevated prices to get in at much better entry points a week or a month from now.
“We’re still bullish, and the odds strongly favor the market’s next pullback or consolidation (which could go on for a few weeks) eventually leading to higher prices,” Mike wrote to his Cabot Growth Investor advisory subscribers late last week. “However, we’re also not eager to dive into a bunch of stocks with both feet right now, as very few are at decent entry points.”
Most of our analysts have echoed Mike’s sentiments in recent days, urging caution with new buys with a stock market pullback becoming not only likely, but inevitable. But a pullback is different from a crash or a true correction. Unless the ongoing fourth-quarter earnings season really disappoints or the coronavirus spreads rapidly in the U.S., chances are the stocks will bounce back.
And when it happens, you’ll know it. The chart will tell you, the VIX will tell you, and we’ll tell you. Keep reading the Cabotwealth.com website to stay on top of what our analysts are recommending on a daily basis. And if you want more in-depth market advice, I highly suggest you subscribe to Mike’s Cabot Growth Investor advisory by clicking here.
Bottom line: don’t fear this stock market pullback. Embrace it. Weather the storm, sell out of any glaring losers or laggards, but hang tight to your winning stocks. A month from now (give or take—again, who knows for sure) could be the perfect time to buy stocks at a discount.
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